Options Volume Spikes on High-Fashion Names

Michael Kors, Ralph Lauren see divergent options strategies

Two fashionable stocks — Ralph Lauren (NYSE:RL) and Michael Kors (NASDAQ:KORS) — became in vogue with option traders yesterday. Speculators are evidently expecting short-term downside out of the former name and moderate upside from Michael Kors.

KORS saw more than 15,000 options trade on Monday (15,000 calls and 509 puts), which is well above the typical average daily option volume of roughly 2,500. optionMONSTER reports that more than 11,000 of the April 50-strike calls were sold at the bid price of $1 per contract (on open interest of fewer than 1,000 contracts). The stock was trading around $46.60 at the time.

If this is a covered call or buy-write trade (combining the sold call with a new stock purchase), the maximum potential profit at expiration is $4.40. This is the credit collected ($1) plus any gains in the stock up to the $50 mark ($50 minus $46.60). The maximum gain is achieved if KORS is trading at (or above) $50 when the options expire, at which point the short call expires worthless.

Maximum loss, should KORS somehow drop all the way to zero ahead of April options expiration, is $45.60, or the stock price at the time of the transaction. Breakeven is also $45.60, so KORS needs to be trading above this level at expiration for the covered-call strategy to be profitable.

If the call was sold “naked” without any accompanying stock position, profit is limited to the $1 credit collected, and losses are theoretically unlimited if the stock rallies, as a short call comes with the obligation to sell the shares at the strike price, no matter how high the stock is trading. This risk is why naked call selling is not for the faint of heart and typically not allowed by many brokerage accounts except for their most advanced traders.

Meanwhile, over in the land of Polo, a trader bought 2,600 April 175 puts and simultaneously sold the same number of April 165 puts. Judging from existing open interest, it appears as though these contracts traded to open. optionMONSTER indicates this was a bear put spread that was purchased for $3.01 per spread. This options strategy takes a long put but offsets the premium cost (and lowers the potential reward) by selling a lower-strike put in the same expiration month.

The maximum loss, should RL be trading above $175 when the options expire, is 100% of this premium paid. The maximum gain is $6.99, or the difference between the long and short strikes less this premium paid. Breakeven for this spread is $171.99. In order for the spread to enter profitable territory, RL will need to drop roughly 3% in the next 32 days ahead of April options expiration.

RL shares have risen 28% so far in 2012 but are currently consolidating just below the $180 region. More than 9% of this gain occurred on Feb. 8, when RL gapped higher following a well-received earnings report. Since then, the shares have been shuffling slowly higher outside of a defined uptrend.

As of this writing, Beth Gaston Moon does not own any shares mentioned here.